Rethinking Valuation and Pricing Models

8

A Jump–Diffusion Nominal Short Rate Model

Sami Attaoui and Pierre Six

Rouen Business School

Chapter Outline

8.1 Introduction

8.2 The Economy

8.3 Equilibrium Interest Rates and Monetary Policy

8.4 A Nominal Interest Rate Model

8.5 Conclusion

8.6 Appendix: Proof of Proposition 2

8.7 Acknowledgments

References

8.1 Introduction

Modeling interest rates has been achieved through two different approaches: The arbitrage-free framework¹ and the equilibrium approach.² The equilibrium setting is very useful to gain insights into the economic background of the model and to understand the interplay between variables. In addition, equilibrium models explicitly specify the risk premia.

Lioui and Poncet (2004) build a general equilibrium model where a monetary ...